The Chancellor could cap a generous tax relief that couples use to protect their money, experts have warned, as Rachel Reeves looks to close the £22bn hole in public finances.
Under the spousal exemption, the biggest and most widely used relief, married couples and civil partners can transfer unlimited assets between each other without having to pay inheritance tax (IHT).
Spouses used this relief to transfer £15.5bn of assets in the 2021 to 2022 tax year. It is the most valuable IHT exemption, making up 68 per cent of reliefs.
Experts said Ms Reeves is likely to review this ahead of the Budget next week, especially as it benefits the wealthiest people.
Under IHT, the nil rate band (NRB), also known as the IHT threshold, usually protects the first £325,000 of your estate from IHT.
Currently, it’s possible to transfer any unused percentage of the IHT nil rate band from a deceased spouse or civil partner to the surviving spouse or civil partner, which is why so many couples have “mirror” wills, designed to give everything to each other.
Introduced in 1972 to ensure partners of those deceased were not faced with large IHT bills, since accrued capital gains are also currently wiped out at death, spouse exemption can result in assets being passed to heirs completely tax-free.
However, a think-tank has said capping the exemption at £10m could improve how fair the system is, as currently the most wealthy are more easily able to use the relief to avoid IHT on large assets including businesses.
The Centre for the Analysis of Taxation (CenTax) said the average effective tax rate is 4 percentage points lower for a family using the spousal exemption.
However, it is 12 percentage points lower if the estate is also worth between £10m and £12.5m and 2 percentage points less for estates valued between £1m and £1.5m.
It wrote: “This may be because those at the top are most able to benefit from the ‘second chance’ to engage in tax planning, which the spouse exemption provides.
“The main aim of the spouse exemption is arguably to ensure that the surviving spouse does not face any material change in their standard of living as a result of IHT due on the first death.
“However, capping the spouse exemption at £10mn could support this goal whilst limiting the opportunity for very high value estates to use the exemption as a second chance for tax planning.”
It said this reform would affect fewer than 0.1 per cent of estates – equivalent to 100 deaths a year – and raise up to £350m in revenue.
The Institute for Fiscal Studies (IFS) has also suggested an alteration to the relief by capping the spouse exemption at a high threshold and increasing the transferable nil-rate band for the surviving spouse by the post-tax amount of assets on which their partner paid inheritance tax.
It said: “Setting a cap at, say, £2.5m would affect less than one per cent of those in couples, but would substantially reduce the ability for this exemption to be used to avoid, rather than defer, large amounts of inheritance tax.
“This ensures some tax is paid on the first death while protecting the standard of living of the survivor or avoiding the same assets being subject to inheritance tax twice.”
While an option, experts have pointed out the change will affect only the wealthiest in society.
Sarah Coles, personal finance expert at Hargreaves Lansdown, added: “If the cap was set high enough it wouldn’t make money from anyone other than the super-rich. At the moment, on the first death, the spectacularly wealthy don’t have to do any tax planning in order to pass everything to one another free of inheritance tax.
“However, on the second death they enter into more complex tax planning in order to avoid inheritance tax altogether. A cap could simply mean they do this before the first death, and find another way to not pay tax.”
Other experts believe any changes to the exemption would not be a good idea.
David Denton, tax expert at Quilter Cheviot, said: “Placing a cap on the IHT spousal exemption would bring in a very minimal amount of revenue for the Exchequer, but would have the potential to further dissuade high net worth individuals from living in the UK which could have a detrimental impact on the economy.
“CenTax’s proposal suggests it would affect approximately 100 deaths a year and would bring in a maximum of just £350mn in revenue – which would be just a drop in the ocean. Inheritance tax is already complex enough, and adding yet another rule for such minimal gain seems nonsensical.”
Charlene Young, pensions and savings expert at AJ Bell, agreed, adding: “It is key exemption that provides financial relief for families at a distressing time. Just because it is the largest exemption used, that does not and should not automatically make it a target for the chop. Primarily it is there to prevent widow/widowers having to sell assets including property to pay an IHT bill.”
Jason Hollands, managing director at wealth management firm Evelyn Partners, said that as the change would not raise much for the Treasury and target those bereaved, it would not be a “good look”.
He said: “The institution of marriage, and civil partnerships, have long been recognised in the UK tax system. Many people feel that passing assets to their life partner, as defined in law, should not be a taxable event, whether it is in life or at death, and so to start to pick away at this would be seen as very concerning.”
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